On May 14, 2019, the U.S. Securities and Exchange Commission (“SEC”) continued its delay on a decision regarding a bitcoin exchange-traded fund (“ETF”) application. A decision regarding the ETF application, filed by Bitwise Asset Management and the NYSE Arca exchange earlier this year, has been delayed several times by the SEC. The SEC is requesting public comment from interested parties on the proposal. This is one of several crypto ETF applications currently in front of the SEC.

Szczepanik Says IEOs Could Create Legal Risks for Exchanges

During the annual Consensus conference in New York, the SEC’s Senior Advisor for Digital Assets and Innovation, Valerie Szczepanik, commented on the recent trend of initial exchange offerings (“IEOs”) that some cryptocurrency exchanges recently launched. She expressed concern that some IEOs could be breaking U.S. securities laws, specifically if they are charging fees for the token offering without registering as a broker-dealer, alternative trading system, or a national securities exchange. Ms. Szczepanik pointed to a recent enforcement action against TokenLot as informative to potential consequences for exchanges conducting IEOs without required registrations. In that action, SEC alleged that TokenLot facilitated ICOs as an unregistered broker-dealer. “Platforms seeking to list these tokens for a listing fee or bring buyers to the table for issuers are probably engaging in broker-dealer activity,” Szczepanik stated.

Tax Bill Regarding Hard Forks to Be Reintroduced in Congress

U.S. Representative Tom Emmer announced plans to reintroduce a tax bill targeted at helping people who hold digital assets that have experienced a hard fork. A hard fork results when changes are made to the blockchain protocol of a particular digital asset and such changes are not adopted by all of the nodes that confirm transactions on the blockchain protocol creating two distinct blockchain protocols that are incompatible. First introduced in 2018, the “Safe Harbor for Taxpayers with Forked Assets” bill would stop the Internal Revenue Service (“IRS”) from imposing tax penalties on the failure to report or the failure to pay tax on taxable income attributed to hard forks. The prohibition would last until detailed guidance on the tax treatment of forked digital assets is released by the IRS.

Emmer, who announced the plans during the Consensus conference, noted that the blockchain education of Congress must continue: “A lot of them have these preconceived notions, all they’ve ever heard of is the Silk Road,” he commented.

SEC Levels Fines Against Canadian Investment Firm

On May 15, 2019, the SEC fined NextBlock Global and its CEO and co-founder, Alex Tapscott, for alleged securities violations. SEC claims that NextBlock, a Canada-based investment firm, has offered securities that were not registered with the SEC and made misrepresentations when soliciting investors. NextBlock and Tapscott agreed to cease and desist from future securities violations and Tapscott agreed to pay a civil penalty of $25,000 USD. The SEC noted NextBlock’s agreement to pay a $700,000 CAD penalty to the Ontario Securities Commission as a factor in not requiring the firm to pay an additional civil penalty. The SEC further notes that Tapscott voluntarily agreed to surrender his share of NextBlock profits resulting from the offering in question, valued at more than $2,000,000 USD.

CFTC Chairman Giancarlo Makes Parting Remarks Regarding Blockchain

This week, the Commodity Futures Trading Commission’s (“CFTC”) outgoing chairman, J. Christopher Giancarlo, gave a farewell address to the blockchain community titled “Free Markets and the Future of Blockchain.” The speech, published on CoinDesk, highlights the measures that the CFTC has taken during the Chairman’s term to address the rapid growth of cryptocurrencies and distributed ledger technology, along with other fintech innovations. Among other things, the Chairman pointed to the LabCFTC initiative, aimed at connecting its regulators with market innovators. The Chairman ended his speech with a full-throated endorsement of free market capitalism to future regulators: “Freedom to act in the marketplace is a part of freedom itself,” Giancarlo stated. “Free markets should be the natural choice of today’s innovators.”

Litigation Updates

Mayweather, DJ Khaled Dismissed from Centra Tech Lawsuit

Four promoters and/or participants of the Centra Tech ICO, including boxer Floyd Mayweather and music producer DJ Khaled, have been dismissed from a lawsuit related to the failed project. Judge Robert Scola granted a motion to dismiss the four individuals from the suit, finding that the plaintiff failed to prove they bought Centra Tech’s CTR tokens due to the defendants’ promotion or participation. The civil suit, brought by investors in the ICO, follows a suit from the SEC along with a grand jury indictment from the Department of Justice against the founders. Last year, Mayweather and Khaled settled charges from the SEC that they failed to disclose that they were paid by Centra Tech to promote the ICO.

NY Court Modifies NYAG Injunction Against Bitfinex and Tether

In the latest update in the ongoing legal saga between Bitfinex, Tether, and the New York Attorney General (“NYAG”), a the Supreme Court of the State of New York has modified an existing preliminary injunction it had granted against Bitfinex and Tether in connection with an investigation into loans between the two sister companies. The newly tailored injunction will last for 90 days and prevent Tether from loaning assets to Bitfinex or other parties, except in the normal course of conducting its business. Additionally, Tether cannot distribute reserve funds to its executives or employees except for normal payroll, contractor, consultant, and vendor payments. Finally, Bitfinex and Tether cannot modify any documents requested in the NYAG’s original subpoena.

The modification comes days after the parties each submitted their own proposed modifications as requested by the court. Attorneys for Tether and Bitfinex asked the court to modify the existing preliminary injunction to a 45-day injunction that would have prevented Tether from entering into line-of-credit transactions similar to the one at issue in the original dispute, but would have allowed affiliated entities to continue to redeem USDT for U.S. dollars. The NYAG’s proposed modification sought a 90-day injunction that would have prevented affiliated entities from accessing Tether’s funds.

International Developments

New Bahamian Rules for Token Sales Proposed

The Securities Commission of the Bahamas has presented a draft of a new bill that seeks to regulate non-security token offerings. The bill would create a process for registering these offerings with the government and providing important details of the offering to investors and government officials via a project memorandum. If significant changes are made to the project, the memorandum must be updated by the offering’s sponsors. Registration would also require hiring a sponsor attorney to regularly communicate with the government about the offering. The law creates strong penalties for failing to comply, including a fine of $500,000 or imprisonment for up to 5 years or a possible 10-year sentence if issuers file misleading registration information. The law would apply to token issuers, wallet providers, crypto exchanges, and individuals facilitating an initial token offering in the country. The draft bill is currently still in a public comment period.

On May 8, 2019, the U.S. Commodity Futures Trading Commission’s (“CFTC”) Division of Enforcement (“DOE”) published its first public Enforcement Manual (the “Manual”). The Manual establishes general policies and procedures for the DOE’s work in investigating and prosecuting violations of the Commodity Exchange Act. Director of Enforcement James M. McDonald commented on the release at the 41st Annual Conference of the Future Industry Association’s Law & Compliance Division, noting that the Manual was publicly released to ensure that the procedures applied by the DOE in investigating and litigating potential violations of the Commodities Exchange Act and regulations thereunder are available to those potentially affected by them. The CFTC has previously asserted that virtual currencies are commodities and has regularly brought enforcement actions against companies and individuals in the virtual currency market.

CFTC Allegedly Ready to Approve Ether Futures

CoinDesk reported this week that the CFTC is ready to approve an ether futures contract if it met the CFTC’s requirements. The CFTC has previously allowed contracts on bitcoin futures. Approving futures on ether could strengthen the CFTC’s claim of jurisdiction over ether, which to date has only consisted of a handful of enforcement actions. The report follows the CFTC’s request for input seeking information about ether and Ethereum from the industry. The CFTC has not made any official statement on the timing for approval of any potential ether derivative products.

On May 9, 2019, the Financial Crimes Enforcement Network (“FinCEN”) released interpretive guidance regarding the application of the Bank Secrecy Act (“BSA”) to companies, platforms and individuals operating in the virtual currency market. The guidance gathers current FinCEN regulations and other administrative rulings and guidance that FinCEN has issued since 2011 and applies them to certain business models in the virtual currency market.

SEC Commissioner Peirce Expresses Innovation-Stifling Concerns

During a speech at the Securities Enforcement Forum in Palo Alto, California, Securities & Exchange Commission (“SEC”) Commissioner Hester Peirce expressed concern that the SEC’s unwillingness to take “meaningful action” is stifling the growth of the crypto industry. In her speech, entitled “How We Howey,” she pointed to what she considers “heel-dragging” on behalf of the SEC to create clear public guidance as to how crypto companies can comply with federal securities law.

With regard to the SEC’s recent framework, she expressed concern that the framework did not give the industry new information to use nor did it provide information as to the weight each consideration listed should be given. Peirce also spoke on the recent TurnKey Jet no-action letter, stating that the offering involved was so clearly not a security that it might have inadvertently broadened the reach of securities laws to items like stored value gift cards. She noted that the Turnkey Jet no-action letter also imposed conditions on a non-security. She noted the lack of guidance from the SEC and the Financial Industry Regulatory Authority on issues like custody of digital assets and argued that the silence is causing a bottleneck for potential brokers and trading platforms. Peirce closed her remarks with a warning that the SEC’s relative silence on crypto “is likely to simply push…innovation and any attendant economic growth into other jurisdictions that have done their work and provided clear guidelines for the market participants to follow.”

Litigation Updates

New Development in Bitfinex/Tether/NYAG Fight

In the latest development in the ongoing legal battle between Bitfinex, Tether, and the New York Attorney General (“NYAG”), a New York state judge ordered that the NYAG’s preliminary injunction against Bitfinex and Tether remain in effect but granted a motion from Bitfinex and Tether to modify the substantive and temporal scope of the injunction. Judge Joel M. Cohen asked the parties to meet and try to agree on a narrower scope for the injunction. He criticized the injunction, calling it “both amorphous and endless.” If the parties cannot agree on a mutual modification, each can offer an individual proposal to modify the injunction. Proposals are due to the court next week.

OneCoin Sued by Former Investor; Possible Class Action

A former investor is suing OneCoin and its principals for alleged fraud and violations of federal securities laws. Christine Grablis is seeking a return of her initial investment of $130,000 plus damages, as well as class action status on behalf of other investors in the project. As we previously reported, federal prosecutors have alleged that OneCoin is an illegal pyramid scheme and a number of people connected with the project have been arrested or are wanted in connection with their involvement in the alleged scheme.

Industry Updates

Binance Loses $40.7M in Bitcoin from Hack

On May 7, 2019, crypto exchange Binance announced that it had been the victim of a hack in which more than 7,000 BTC (~$40.7M) was stolen from the exchange’s hot wallet. Binance is still investigating the attack, but has stated they believe the hackers were “able to obtain a large number of user API keys, 2FA codes, and potentially other info.” Binance also reported that the hackers “used a variety of techniques, including phishing, viruses and other attacks.”

Binance plans on using its Secure Asset Fund for Users (“SAFU”) to cover the losses. SAFU, which is funded from 10% of all Binance trading fees, was created last year to provide protection to users in case of an event like this week’s. Binance’s CEO, Changpeng Zhao, stirred some controversy by suggesting that Binance might encourage bitcoin miners to “rollback” the bitcoin blockchain, essentially reversing transactions on the chain to return the stolen funds. Such a rollback would require gathering more than 51% of the bitcoin network’s hashing power to create a new version of the existing chain where the transfer of the stolen coins from the hot wallet never occurred. Many were quick to criticize the move as an affront to the basic spirit of bitcoin and its chain’s immutability. Zhao clarified in a subsequent tweet that Binance would not pursue the rollback idea.

iFinex Planning $1B Initial Exchange Offering

iFinex, the parent company of Bitfinex and Tether, confirmed that it will be conducting a $1 billion initial exchange offering (“IEO”), releasing a white paper on May 8, 2019. The new token, which would trade under the symbol LEO, would allow users discounts on trading fees on the Bitfinex, Ethfinex, and eosfinex exchanges. The token would be purchased using USDT, the stablecoin issued by Tether. The IEO would be sold as a private offering and require a 1 million USDT buy-in to participate. The IEO will be unavailable to U.S. customers.

The white paper also contains several other announcements of note. First, iFinex is planning to launch an IEO platform that would allow other tokens to launch via an IEO on its exchanges. Next, iFinex is working to create a licensed and regulated securities exchange and, while it does not specify which regulator would be licensing the exchange, it notes the exchange would be unavailable to U.S. customers. Last, the white paper notes a forthcoming derivatives product involving USDT-based collateral.

New Crypto ETF Filed with SEC

An application for a new cryptocurrency exchange-traded fund (“ETF”) has been filed with the SEC. The application was filed by Crescent Crypto Index Services and is sponsored by the United States Commodity Funds LLC. According to the SEC filing, the USCF Crescent Crypto Index Fund would trade on the NYSE Arca under the ticker symbol XBET and pursue its investment strategy by investing in bitcoin and ether in order to generate returns that are based upon the Crescent Crypto Core II Index, an index designed to “track the performance of a market capitalization weighted portfolio of Bitcoin and Ether.”

The filing follows several other crypto ETF applications that have been filed with the SEC. No crypto ETFs have been approved by the SEC and decisions about the fate of two other proposed ETFs, the Bitwise Bitcoin ETF Trust and the VanEck SolidX Bitcoin Trust, have been delayed while the SEC continues to consider their filings.

International Developments

Liechtenstein Passes New Blockchain Regulation

On May 7, 2019, Liechtenstein passed the Token and VT Service Providers Act (the “Act”). According to an official press release, the Act covers “transaction systems based on trust technologies,” a definition intentionally broad so as to cover “the next generations of technology.” The Act was passed, in part, to ensure consumer protection and fight illicit use and money laundering. According to the press release, the Act clarifies questions as to how current laws apply to tokens and blockchain technology. The Act also addresses property rights as it relates to tokens.

Australian Securities Exchange Opens DLT Development Environment

On May 7, 2019, the Australian Securities Exchange (“ASX”) announced the opening of a new equities clearing and settlement system, the Customer Development Environment (“CDE”). The CDE, which uses distributed ledger technology (“DLT”), replaces the existing CHESS system. The first “drop” of code for the CDE was released on April 30, 2019, with another six drops scheduled at an eight-week cadence. Using DLT will allow customers to connect via a system node, providing quick access to source-of-truth data. CDE was built using Digital Asset’s open source smart contract language, DAML.

Crypto Assets Noted as a Priority for IOSCO

The International Organization of Securities Commission’s (“IOSCO”) Board recently released a list of priority issues for 2019, with crypto assets listed as one of the priorities. The Board states that IOSCO will focus on “how platforms where crypto-assets are traded are regulated and will also examine regulation of investment funds with exposures to crypto-assets.” IOSCO will also create a portal for members to share information on enforcement efforts. In addition, IOSCO will continue its development of an “ICO Support Framework,” aimed at helping members address domestic and international issues related to initial coin offerings.

On April 29, 2019, the U.S. Securities and Exchange Commission (“SEC”) announced that it was suspending trading for Bitcoin Generation (“BTGN”), a cryptocurrency exchange and mining company, until 11:59 p.m. ET on May 10, 2019, due to concerns about the accuracy and adequacy of information in the marketplace. Specifically, the SEC was concerned about “(1) BTGN’s public statements regarding the viability and valuation of a bond that BTGN purportedly acquired from an entity based in the United Kingdom; (2) the amount of BTGN’s outstanding common stock; (3) stock promotional activity relating to BTGN and the market impact of such promotional activity; and (4) the accuracy and adequacy of current public information regarding BTGN’s financial condition.” BTGN merged with Inolife Technologies and Inolife Technologies Operations in 2018 and offers two ERC20 tokens, the BTGN token and the Bitachon token. BTGN holds itself out as specializing in the development of blockchain technology applications, cryptocurrency mining and operating a “publicly traded cryptocurrency exchange.”

BTGN issued a response to the SEC’s trading suspension on April 30, 2019, which called the SEC’s action “surprising and highly prejudicial,” but also stated that it intended to comply fully with the SEC’s requests and the requests of any other regulatory agencies concerning the company’s operations.

CFTC Chairman Giancarlo Suggests Revising CEA to Address Crypto

On May 1, 2019, Commodity Futures Trading Commission (“CFTC”) Chairman J. Christopher Giancarlo testified before the House Committee on Agriculture about the state of the CFTC. During his testimony, Chairman Giancarlo addressed issues related to cryptocurrency. He noted that he anticipated that the CFTC will receive new applications for clearinghouse registrations attributable to the “explosion of interest in cryptocurrencies.” Additionally, Chairman Giancarlo stated in response to questions from the committee that he thought it necessary to give the CFTC greater oversight of cryptocurrencies to keep pace with emerging technologies. You can read Chairman Giancarlo’s testimony here.

OCC Seeks Comments on Proposed Innovation Pilot Program

The Office of the Comptroller of the Currency (“OCC”) is soliciting public comment on its proposed Innovation Pilot Program. For more information on the proposed Program, please visit our sister blog, The FinTech Report.

OFAC Issues Framework for OFAC Compliance Commitments

On May 2, 2019, the Office of Foreign Assets Control (“OFAC”) published guidance entitled “A Framework for OFAC Compliance Commitments.” OFAC’s Framework clearly establishes the agency’s expectations regarding an effective sanctions program. Perkins Coie has published an update with in-depth review of the framework with important takeaways. The update can be found here.

Government Blockchain Bill Introduced in Ohio

On April 24, 2019, Representative Rick Carfagna (R-Dist. 68) introduced a bill (HB 220) in the Ohio House of Representatives that would allow the state government and other government entities to adopt blockchain technology to conduct government functions such as recording licenses. The bill has been referred to the Commerce and Labor Committee.

Washington State Enacts Distributed Ledger Technology Law

On April 26, 2019, Washington State Governor Jay Inslee signed into law a bill (SB 5638) that is designed to encourage the development of distributed ledger technology. The bill defines establishes that an “electronic record may not be denied legal effect, validity, or enforceability solely because it is generated, communicated, received, or stored using distributed ledger technology.” Distributed ledger technology is defined as “any distributed ledger protocol and supporting infrastructure, including blockchain, that uses a distributed, decentralized, shared, and replicated ledger.” Blockchain is defined as “a cryptographically secured, chronological, and decentralized consensus ledger or consensus database maintained via internet, peer-to-peer network, or other similar interaction.” The law will take effect July 28, 2019.

Litigation Updates

Bitfinex and Tether Respond to the NY Attorney General

Last week, we discussed the New York Attorney General’s (“NYAG”) court order enjoining iFinex Inc., operator of the Bitfinex trading platform, and Tether Limited, issuer of “tether” virtual currency, from further violations of New York law in connection with potential acts of fraud.

Since the NYAG’s April 25 order, the general counsel for Tether filed an affidavit in support of an order to show cause to vacate or modify the NYAG’s order. In addition to challenging the NYAG’s allegations as being based on a misunderstanding of the arrangement between Bitfinex and Tether, the affidavit claimed that Tether had on hand cash or cash equivalents totaling approximately $2.1 billion, which represented about 74% of the current outstanding tethers.

On April 30, 2019, the Supreme Court of the State of New York ordered the NYAG’s office to show cause why the Court should not issue an order vacating or modifying the NYAG’s initial order. The Court required the NYAG to show why Bitfinex and Tether should be restrained from accessing, lending, extending credit, encumbering, pledging, or making any other claim on the U.S. dollar reserves held by Tether. Vacating this preliminary restraint would enable Bitfinex and Tether to access Tether’s line of credit to Bitfinex. Both the NYAG and the defendants now have motions before the Court to argue the appropriateness of the NYAG’s injunction.

DOJ Announces Charges Against Crypto Shadow Bankers

On April 30, 2019, the U.S. Department of Justice (“DOJ”) unsealed a grand jury indictment in the Southern District of New York and announced charges against two individuals who opened up numerous bank accounts to offer fiat-currency banking services to various cryptocurrency exchanges between February and October 2018. The defendants each face charges with penalties of up to 30 years imprisonment. One of the individuals is located in the United States, and the DOJ is seeking pre-trial detention due to concerns that he may flee the country. According to the DOJ, the defendants allegedly committed bank fraud using a system of bank accounts to deposit funds to cryptocurrency exchanges. The indictment includes charges of bank fraud and operating an unlicensed money transmission business, and conspiracy to commit these offenses. In its announcement, the DOJ stated that the defendants “allegedly ran a shadow bank that processed hundreds of millions of dollars of unregulated transactions on behalf of numerous cryptocurrency exchanges” and thereby “skirted the anti-money laundering safeguards required of licensed institutions.” According to a workbook found by investigators, the alleged shadow banking operation received over $740 million in 2018 and has a combined account balance across over 60 bank accounts around the world of over $345 million. The DOJ notes that agents from the FBI’s New York Money Laundering Investigations Squad and the U.S. Internal Revenue Service participated in the investigation.

Industry Updates

Report that More Than 20% of Institutional Investors Own Digital Assets

Fidelity Investments and Fidelity Digital Assets recently reported on a survey that shows that nearly one-half of institutional investors believe digital assets have a place in their portfolio, with over 20% of institutional investors already owning digital assets and roughly 40% saying they are open to future investments in digital assets over the next five years. Digital assets are well-regarded, with 74% of financial advisors and 80% of family offices viewing the characteristics of digital assets most favorably. The survey indicated that the way investors would prefer to hold digital assets differs, with 72% preferring to buy investment products that hold digital assets, 57% preferring to buy digital assets directly, and 57% preferring to buy an investment product that holds digital asset companies. The survey was conducted by Greenwich Associates on behalf of the Fidelity Center for Applied Technology and included over 400 U.S.-based institutional investors.

On May 2, 2019, the central banks of Canada and Singapore, the Bank of Canada and the Monetary Authority of Singapore, announced that they had used central bank digital currencies to conduct the first successful experiment on cross-border and cross-currency payments. Each central bank has an experimental domestic blockchain payments network, Project Jasper and Project Ubin, respectively. The projects are built on different blockchain platforms, with Project Jasper developed on R3’s Corda, and Project Ubin developed on JP Morgan’s Quorum. The two central banks used a technique called Hashed Time-Locked Contracts to connect the two networks to allow direct payment versus payment (“PvP”) settlement to occur without the need of a trusted third-party intermediary. Accenture and J.P. Morgan partnered with the central banks to conduct the experiment. Upon the conclusion of the experiment, the central banks have also jointly issued a report discussing the project and proposing different design options for such cross-border settlement systems.

India Purportedly Considering Banning Use of Crypto

On April 26, 2019, as reported by the Indian newspaper, The Economic Times, India’s government announced that it was engaging in inter-ministerial consultations on a draft bill that would ban use of all cryptocurrencies and regulate official digital currencies. A final law will be proposed to the next government after elections at the end of May 2019. The draft bill stems from work done last year by a government panel related to cryptocurrencies, which included India’s Department of Economic Affairs, Central Board of Direct Taxes, Central Board of Indirect Taxes and Customs, and the Investor Education and Protection Fund Authority.

]]>https://www.virtualcurrencyreport.com/2019/05/blockchain-week-in-review-week-of-april-29-may-3-2019/OFAC Issues Sanctions Compliance Program Guidancehttp://feeds.lexblog.com/~r/VirtualCurrencyReport/~3/tOlOsn1tMQE/
Tue, 07 May 2019 19:18:49 +0000https://www.virtualcurrencyreport.com/?p=3914Continue Reading]]>The Office of Foreign Assets Control (OFAC) administers and enforces U.S. economic sanctions programs in accordance with U.S. national security and foreign policy. OFAC had not previously published guidance addressing essential elements for an effective sanctions compliance program (SCP). It has now done so.

Specifically, on May 2, 2019, OFAC published guidance entitled “A Framework for OFAC Compliance Commitments.” OFAC’s Framework clearly establishes the agency’s expectations regarding an effective SCP. Given the importance OFAC places on an effective SCP in its enforcement decisions including the determination of the amount of any civil penalty, companies with international activities should consider whether to update their SCP to meet the agency’s standards.

In this update, we detail the OFAC Framework and outline several OFAC sanctions compliance breakdowns to avoid.

New York Attorney General Announces Filing in Connection with Tether, Bitfinex Investigation

On April 25, 2019, New York Attorney General Letitia James announced that her office obtained a court order enjoining iFinex Inc., operator of the Bitfinex trading platform, and Tether Limited, issuer of “tether” virtual currency, from further violations of New York law in connection with potential acts of fraud. Bitfinex’s response to the Order can be found here.

New York’s Office of the Attorney General has expressed concern regarding the potential for conflicts between the interests of virtual asset trading platforms, platform insiders, and customers, and one of the primary objectives of this Order is to address the potential loss of customer funds.

“Our investigation has determined that the operators of the ‘Bitfinex’ trading platform, who also control the ‘tether’ virtual currency, have engaged in a cover-up to hide the apparent loss of $850 million dollars of co-mingled client and corporate funds,” said Attorney General James. “New York state has led the way in requiring virtual currency businesses to operate according to the law. And we will continue to stand-up [sic] for investors and seek justice on their behalf when misled or cheated by any of these companies.”

iFinex and Tether must appear in the Supreme Court of the State of New York next month.

New York District Attorney Announces Guilty Plea in Cryptocurrency Money Laundering Case

The Manhattan District Attorney announced on Tuesday, April 23, 2019 that two individuals pled guilty for running a steroid and controlled substance business that laundered millions of dollars in cryptocurrency. This is among the first money laundering convictions involving cryptocurrency by New York State prosecutors.

The full announcement from the Manhattan District Attorney’s office can be found here.

FINRA Forms New Office of Financial Innovation

On April 24, 2019, FINRA announced that it is forming an Office of Financial Innovation that will coordinate issues related to financial innovation and, in particular, new uses of financial technology. Haimera Workie has been named the head of the new office.

“Innovation continues to pose new opportunities and challenges for our member firms and the broader financial services industry, and it is essential that we as regulator keep pace,” said FINRA President and CEO Robert W. Cook.

CNStock, a financial news source in China, reports that the State Administration of Foreign Exchange (“SAFE”) has built a blockchain platform to facilitate cross-border trading. SAFE is reportedly piloting the new platform in three major provinces, Jiangsu, Zhejiang, and Fujian, as well as in the cities of Shanghai and Chongqing. The pilot is designed to streamline processes involved in importing and exporting goods, including import and export receivable financing and verification of customs paperwork. China’s existing method for import/export processing relies on multiple manual processing interactions, which leads to significant delays and increased demurrage and per diem charges for cargos and resulting financing arrangements. The pilot is expected to run for six months before a decision is made to expand use of the platform nationwide.

Following last week’s report from Reuters that Japan’s Financial Services Agency (“FSA”) may require additional oversight of cryptocurrency exchanges in light of a series of security lapses by Japanese exchanges last year, Reuters now reports that two such exchanges were raided last week to investigate their internal oversight, including customer protection and anti-money laundering practices. Specifically, Reuters reports that the FSA conducted inspections at Huobi Japan Inc and Fisco Cryptocurrency Exchange Inc, both of which recently underwent significant management changes.

The Reserve Bank of India (“RBI”) recently announced the framework for its fintech regulatory sandbox to foster “learning by doing,” which will allow regulators to obtain first-hand experience with and understand the benefits and risks of emerging financial technology. However, because Section 6.3 of RBI’s framework explicitly excludes cryptocurrency businesses, this framework is not a sign that RBI is shifting its position on cryptocurrency as reported last summer.

French National Assembly Adopts New Blockchain Bill

On April 11, 2019, the French National Assembly adopted the Plan d’Action pour la Croissance et la Transformation de Enterprises (PACTE – Action Plan for Business Growth and Transformation) that, once enacted, will establish a framework for cryptocurrency-based fundraising and for digital asset services providers. If blockchain companies opt into the regulation, that is, they meet certain requirements to obtain a “visa” or license with the country’s financial markets overseer, then this new law grants these companies the right to a bank account and places the burden on the banks to explain why they will not serve a particular business. Businesses that opt not to obtain a visa or license will be prohibited from solicitation, patronage, and sponsorship activities.

Binance Launches Decentralized Exchange

On April 23, 2019, Binance, the world’s largest cryptocurrency exchange, launched a decentralized exchange that operates on top of the company’s Binance Chain, a blockchain system that was also launched last week.

“We believe decentralized exchanges bring new hope and new possibilities, offering a trustless and transparent financial system. . . . With no central custody of funds, Binance DEX offers far more control over your own assets,” said Binance CEO Changpeng Zhao.

Arca Investment Management, a California-based investment management firm specializing in digital assets, filed an amended preliminary prospectus with the SEC seeking to make available its Arca UST Coins to investors. The Arca U.S. Treasury Fund (“Fund”) would issue its shares as “Arca UST Coins,” which are digitized securities that would be ERC-20 compatible tokens and utilize the Ethereum blockchain.

In compliance with the “Names Rule” under the Investment Company Act of 1940, the Fund will invest at least 80% of its assets in U.S. Treasury Securities, which could include bills, bonds, and notes issued by the U.S. Treasury; the remaining assets would be held in cash, cash equivalents, or investment-grade bonds. The Fund is designed to function as a stablecoin, because it is structured to have little volatility between the “net asset value” per share and the coin’s value for purposes of trading in a secondary market. The Fund’s shares will be issued as a digitized security token, and all transactions, including issuance and transfer, will be recorded on the Ethereum blockchain, with ownership and transfer of the Arca UST Coin authenticated through cryptography. Arca Investment Management seeks to raise $25 million with its offering.

In order for an investor to own Arca UST Coins, the investor has to establish a wallet on the Ethereum blockchain through the Arca application and be accepted by Arca’s affiliated transfer agent (for Anti-Money Laundering/Know Your Customer purposes). After the investor’s wallet address is approved and “whitelisted,” the investor can then use the Arca application to transfer funds from a bank account directly to the Fund and receive the Arca UST Coins directly into his or her wallet. According to the preliminary prospectus, the private keys with respect to issuance transactions are maintained by the Fund’s transfer agent, which also must confirm any transactions (such as on a decentralized exchange). The Fund’s custodian is also an affiliated party.

The Form N-2, which is a registered investment company registration statement, is not effective until the SEC declares the filing to be effective. This would be the first registered investment company to use a blockchain for share registration, issuance, and redemption transactions.

Among other things, FinCEN determined that the individual operated as a money transmitter by conducting transactions as a “peer-to-peer exchanger.” Per a footnote in the assessment, FinCEN defined “peer-to-peer exchanger” as “a natural person engaged in the business of buying and selling convertible virtual currency, who typically advertises and markets his or her services through classified ads, specifically designed web platform websites, online forums, other social media, and word of mouth.”

The full FinCEN Assessment of Civil Monetary Penalty is available here.

This week Democratic presidential candidate Andrew Yang called for federal regulation of cryptocurrencies and digital assets. Yang noted the current regulatory uncertainty and conflicting state regulations and said that investors, companies, and individuals would all benefit from clarity in the treatment of crypto/digital assets. Yang calls for legislation to define what a token is and when it is a security, while recognizing utility tokens; confirm which federal agencies have regulatory power over digital assets; clarify the tax implications; and preempt state regulations when possible. For more information, see Andrew Yang’s policy here.

Industry Updates

Decentralized Exchanges May Be Subject to Arbitrage and Frontrunning Used on Wall Street

According to a new research paper from scholars at Cornell Tech, decentralized exchanges (“DEXes”) are susceptible to the same exploits that high-frequency traders use on Wall Street. In the paper, Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges, researchers claim that arbitrage bots “exploit inefficiencies in DEXes, paying high transaction fees and optimizing network latency to frontrun, i.e., anticipate and exploit, ordinary users’ DEX trades.” Similar to how Michael Lewis’ book Flash Boys: A Wall Street Revolt shined light on high-frequency trading is used to gain an advantage over traditional trading, the authors of Flash Boys 2.0 highlight risks in current smart contracts and decentralized exchanges.

Arbitrage bots leverage “pure revenue opportunities” and “priority gas auctions,” two specific kinds of transactions on the blockchain, to ensure profits over a series of transactions. The researchers created a fork in the Go-Ethereum client to enable a tool created by the researchers to capture unconfirmed transactions to identify priority gas auction arbitrage bots. The researchers collected over 708 million unique observations of arbitrage bots during the nine months of gathering data. As the arbitrage bot market matured, revenues dropped from around 10-100 ETH per day in late 2017 down to 1-10 ETH per day for bots making over 1,000 daily trades.

The scholars highlight the differences between blockchain payment protocols and smart contract systems. Blockchain payment protocols, such as bitcoin, are secure simple payments and are executed atomically, so they are generally unprofitable to manipulate. Smart contract systems, such as Ethereum, use a second-layer system added on top of the bitcoin miners and adds a layer of dependence vulnerable to exploitation. The researchers warn that arbitrage bots may drive up order optimization fees and transaction fees beyond the block reward for the miner. If the optimization fees and transaction fees greatly exceed the block reward, the researchers argue that a miner might attempt to undercut a high-fee block and fork the block to hold back fees to attract other miners to build on the new fork. Additionally, the researchers caution that time-bandit attacks, wherein a miner utilizes a 51% attack to fork and recapture optimization fees and transaction fees, may already be profitable on certain blocks with high fees or arbitrage opportunities.

EY Will Make Its Zero-Knowledge Proof Private Transaction Protocol Publicly Available

Following up on EY’s initial unveiling in October 2018, EY announced it will release its zero-knowledge proof (“ZKP”) private transaction protocol into the public domain. The protocol is designed to allow “secure, private transfers and payments on the public Ethereum network.” The transactions using the ZKP technology will be kept private so that blockchain users who are outside of the transaction or not authorized to view the information will not have access. The transaction information will be available to auditors and regulators. The protocol will support ERC-20 standard fungible token payments and unique asset transfers compatible with the ERC-721 standard. EY expects the software code to be released into the public domain in the next four to six weeks.

The Enterprise Ethereum Alliance (“EEA”) announced the launching of the Token Taxonomy Initiative to help jumpstart token-powered blockchain platforms. The Token Taxonomy Initiative seeks to clearly define a token in layman’s terms and establish a common nomenclature for use by businesses and technical participants. Additionally, the Token Taxonomy Initiative strives to create a simple and easy-to-understand Token Taxonomy Framework and collaborate with structured Token Definition Workshops to define new or existing tokens, and it aims to define metadata using the Token Taxonomy Framework to help enable generation of visual representations and mappings of token solutions, implementations, or source code for any platform. The Enterprise Ethereum Alliance consists of over 300 member companies across 19 technical, industry, and legal groups. For an overview of the Token Taxonomy Initiative, review the EEA Token Taxonomy Initiative flier.

According to a Reuters report, Japan’s Financial Services Agency (“FSA”) may require additional internal oversight of “cold wallets” in light of virtual exchanges’ shift from internet-connected “hot wallets” to cold wallets. Cold wallets are devices disconnected from the internet and have been utilized more by virtual exchanges following a series of security lapses by Japanese exchanges last year. It is not yet known when the FSA will formally issue the order.

French Finance Minister Bruno Le Maire Asks for European Union to Regulate Cryptocurrency

At Paris Blockchain Week, French Finance Minister Bruno Le Maire called upon the European Union to enact a regulatory framework for cryptocurrencies that mirrors the French regime enacted earlier this April. In a speech, Le Maire highlighted the construction industry, the agriculture and food industry, and the energy industry as the three industrial sectors that will engage in developing and utilizing blockchain technology with France’s support. Le Maire believes that the French regulatory proposals create “a unique worldwide framework for ICOs” (translated) and encourage working on regulating cryptocurrency at the G20 level. Le Maire offered an overview of his statements on his Twitter account.

Japanese e-Commerce Company Rakuten Launches Applications for Cryptocurrency Exchange

Japanese e-commerce giant Rakuten began accepting applications this week for a new cryptocurrency exchange, Rakuten Wallet. In 2018 Rakuten purchased the exchange, which was formerly named Everybody’s Bitcoin. Under Japan’s Payment Services Act, cryptocurrency is regulated by the FSA and requires, among other things, that currency exchanges register with the FSA and manage customers’ money separately from their proprietary funds. Initial applicants must already have an existing Rakuten Bank account. For more information, see the official Rakuten (Japanese) press release.

Recently, Forbes published an article detailing the ways that large companies, including some of the best-known companies in tech, finance, manufacturing and retail, are forming or joining blockchain consortia or other proprietary blockchain projects. The Forbes article reflects an uptick in enterprise engagement with blockchain, a trend Perkins Coie’s blockchain group has also seen in recent months. Specifically, across industries, companies are coming together to form and participate in blockchain consortia, which allows them to address common issues and challenges—in their industry or with each other—by leveraging the tremendous potential of blockchain and distributed ledger technology (“DLT”). Whether to help address business or operational challenges, or unlock new business models and opportunities, DLT is fueling a new collaborative trend among enterprises. Blockchain consortia are emerging as the vehicle enterprises are using to drive toward common goals and desired objectives.

The Current Enterprise Trend

Joining or forming a consortium is not a new concept, especially in the blockchain community. However, we’ve observed a recent trend in which consortia are being formed not to build new private blockchain protocols, but rather to collaborate in developing enterprise-hardened business and operational solutions using (or based on) existing blockchain protocols, whether public or private, such as Ethereum, Hyperledger Fabric or Ripple. These consortia are seeking to leverage DLT to solve common operational problems or unlock new opportunities, not to reinvent the blockchain protocol wheel.

Blockchain is an inherently collaborative technology, where collaboration and effective interaction among constituents is key to success and the network effect is a core driver of value, in that the value of the platform increases with the increase in participation by constituents. Given the underpinning of the technology, collaborative innovation is necessary for a community of developers, participants and others to create the layers of functionality that interact with one another to produce the optimal and desired experience or use case.

For these reasons, consortia have emerged as potentially transformative tools for companies and other organizations that are seeking to explore or adopt blockchain or DLT solutions. They allow companies and organizations to leverage valuable technological and business insights, intra- or cross-industry connections, and policy and public advocacy resources. They also provide a forum for devising interoperability standards that can facilitate more seamless adoption of DLT solutions within an industry or sector. Just as importantly, consortia allow their members to share the burdens of development and experimentation across the membership, providing greater efficiency at a lower cost.

Navigating the Factors that Shape the Outcomes of Successful Blockchain Consortia Engagements

Perkins Coie’s blockchain group has reviewed many consortia across a dozen industries, encompassing different member populations within an individual industry or across industries and containing members from a single country, a geographic region or worldwide. Based on this analysis, we have identified several specific interdependent and complex factors that play vital roles in shaping the outcome of the efforts around forming or participating in a consortium and contributing to the success or failure of blockchain consortia. Specifically, we have identified thirty-four distinct factors, which we have organized into five buckets. Some of these factors are straightforward, but the majority present several possible paths, the optimal one of which will be dependent on the specific goals of the consortium, or are themselves dependent on other factors, such that decisions among multiple factors must be coherent and coordinated. Such factors include legal structure, governance, and intellectual property contribution and distribution. We are happy to help clients navigate these many factors and their legal and regulatory implications.

We’ve organized and analyzed each of the thirty-four factors in a report, laid out in the following format. Below is a sample of our analysis of the factor addressing a consortium’s economic and financial model:

Consortium Economic Model

Description:

Consortium economics and financial costs depend on various factors, including membership composition, business objective, industry and technology implementation.

Among the most common methods of consortia financing is the use of membership fees. The use of fee proceeds varies by consortia, but fees often cover administrative, maintenance and ongoing development costs. Consortia that operate in a cross-disciplinary industry or that rely on a broad membership base may seek graduated membership financing, where small/non-profit enterprises and individuals pay lower membership dues than larger enterprises.

Alternative financing models include founding member financing, equity financing, debt financing, token financing or a combination of methods. Founding member financing is more common when a single enterprise or organization leads the consortium and may be in a unique position to profit from operations. Some consortia rely on venture capital financing, using convertible debt instruments (e.g., SAFEs) to fund operations.

A small subset of consortia has products that are monetized through licensing or user fees as part of their overall economic model. These consortia often provide closed-source blockchain products within an industry or business vertical.

Key Considerations:

A consortium cannot operate without funding or a plan for how to deploy those funds.

If a consortium cannot raise funds, raises funds from the wrong sources or spends funds in an inefficient way, it will be unable to achieve its business objective and it can expose the consortium, its leadership and its members to legal liability.

A consortium’s approach to its economic model will directly or indirectly influence almost every facet of a consortium’s design and operations, and therefore will affect many other consortium factors. The economic model will most directly impact the following factors, however:

Formation and Legal Structure: The choice of legal structure—for example, a joint venture or a nonprofit corporation—will dictate different approaches to both raising and spending funds.

Operational Management: A consortium cannot manage operations without adequate funding and a process for deploying that funding.

Information Auditing: A consortium’s financial model will dictate its audit and recordkeeping needs and requirements.

Findings & Market Observations: Many consortia are member-financed via annual membership dues. Some consortia have graduated membership fee structures based on various criteria (often the size of the enterprise seeking membership or whether the member is a for-profit or nonprofit organization). Other consortia are funded by initial founding members with special participatory rights. Subsequent members in founder-funded consortia often have different or fewer rights than the founders. Some consortia are government-financed or structured as nonprofit organizations and may be financed by charitable giving. Government-financed consortia in the United States are typically financed in the form of grants (e.g., Consortium A). Some international consortia are financed through direct participation with governmental entities (e.g., Consortium B, which is financed in part by Government Z).

Recommendations: Consider the best fee structure to serve the business objective of the consortium. If the consortium desires to attract a broad membership base, the consortium should consider a tiered or graduated membership fee structure with fee categories targeted to attract the different types of participants required for its success. Consortia organized as legal entities may benefit from founder financing to cover startup and organizational expenses but must also consider how new membership onboarding will occur and how financing will be sustained over time.

Issues to Consider When Assessing This Factor: Consortia funding models will depend on various factors, but the choice of model should be designed to support the objectives of the consortium. Legal structure, governance structure, member authority/control, and member contributions and obligations will also significantly impact funding (monetary or in-kind contributions) and risk allocation. There also may be tax benefits (or burdens) to establishing a separate legal entity for the operation of the consortium.

Tax and revenue-sharing considerations, often driven by the structure of the consortium, also play an important role. With respect to taxes, members in a contractual consortium may receive fewer tax benefits compared to members in an incorporated consortium, and separately created legal entities may be able to take advantage of tax deferral and other strategies not available to contractual consortia. With respect to revenue sharing, contractual revenue-sharing agreements among members can create inefficiencies, particularly when rights, obligations and liabilities are unequally distributed between new and old members. Other considerations for revenue sharing include ease of administration, transparency, triggering events, obligations, indemnification, transferability and exclusivity.

An often-overlooked economic factor is the expectation of contributions of time, personnel and technology from the consortium members. Many consortia operate with a skeletal, largely administrative staff, and expect members to contribute significant time, resources and intellectual property to do the work of the consortium through participation in working groups and project teams. In such consortia, the economics of the membership fee may be dwarfed by the value of these member contributions. This can raise concerns of free-riders—members that pay their fees and gain the benefits of membership, but do not participate in the operations of the consortium.

Examples: Consortium C is financed by membership fees and has adopted a graduated membership fee structure based on organization size. Consortium C seeks to represent a broad swath of businesses in its working groups by allowing some smaller enterprises to participate free of cost, while larger enterprises (X,XXX or more employees) may owe as much as $XX,000 in annual fees. Other broad member-financed consortia include Consortium D, Consortium E and Consortium F.

Consortium G is financed by multiple means. Consortium G has membership fees, received venture financing and received startup capital from its founding members. Consortium G also offers consulting services and enterprise products, although it is unclear whether these services and products are or will become revenue-generating. It is also unclear how Consortium G’s products and services are or will be priced and whether product and service revenue will eventually reduce or replace membership fees. Other consortia with similar products and services include Consortium H and Consortium I.

Some consortia are financed by government grants. Consortium J is the recipient of a $X million X-year grant awarded in 20XX. Consortium J also has received donations from various enterprises.

Some consortia organize as tax-exempt entities within their jurisdiction. Consortium K is a tax-exempt 501(c)(6) organization. Consortium L is also a tax-exempt organization.

Trends and Observations: The member fee model currently dominates the consortia economic model factor. Some consortia also seek venture financing or government grants instead of, or as a supplement to, membership fees. Operational costs vary depending on consortia objectives, products and services. For consortia that have developed proprietary blockchain or DLT solutions, it is unclear whether these consortia have realized profits from their operations.

* * * *

An enterprise considering whether to form or join a blockchain consortium cannot merely go through the factors one by one looking for their presence or absence; rather, only through a thorough and comprehensive analysis of the factors as a whole can an enterprise gain confidence in the chances of success of a specific consortium project. We have assisted many clients in establishing or evaluating blockchain consortia, and with our data-based analysis and our evolving methodology for guiding our clients in assessing their journeys with consortia, we help clients balance the delicate business and political issues involved in bringing diverse companies together to form a consortium while allowing them to remain focused on the purpose and benefits associated with such efforts.

Conclusion

Collaboration among industry players as they explore blockchain and DLT solutions can yield great successes, but also can lead to failures unless a careful and comprehensive approach and methodology is used to consider the complex and interwoven factors that could determine the fate of such effort. While blockchain and DLT technology can fuel success and industry transformation, the lack of thoughtful planning and execution can lead to wasted investment and multitudes of challenges to all involved. Perkins Coie’s blockchain group stands at the intersection of these complex technology, business and legal issues with the acumen to help guide our clients and partners. Please contact the authors of this post if you would like to learn more.

Blockstack, the New York-based blockchain software provider, has announced that it intends to make a $50 million token offering that would use the SEC’s Regulation A+ exemption. The sale would enable Blockstack to raise capital through the U.S. securities markets via a subsidiary, Blockstack Token LLC, and would be the first SEC-qualified token offering of its kind.

While Blockstack’s offering requires further regulatory review, a Regulation A+ offering provides an alternative to a traditional IPO. Passed as part of the 2012 Jumpstart Our Business Startups (JOBS) Act, the exemption is intended to give companies wider access to the public investing community and to support small business growth and employment by lowering regulatory hurdles for companies trying to raise capital. In addition to exemption from registration, a company filing under Regulation A+ may confidentially submit its offering memorandum to the SEC, undergo an expedited review process, and have fewer ongoing public disclosure requirements.

This week, U.S. Representative Warren Davidson (R-OH) introduced the Token Taxonomy Act of 2019, which would exclude digital tokens from the definition of “security” and provide guidance on how the SEC may approach cryptocurrency regulation.

The bill was initially proposed last December by Representatives Warren Davidson and Darren Soto (D-FL), but received little traction. This newest version clarifies the jurisdictions of the Commodity Futures Trading Commission (CFTC) and the Federal Trade Commission (FTC) and states that it seeks to preempt state regulations like New York’s BitLicense. Issues previously flagged by industry leaders remain, including uncertainty over potential tax implications.

Davidson’s press release calls attention to the growing strength of the digital asset and blockchain industries in both Europe and China and rallies for U.S. leadership within the global market.

Utah Exempts Blockchain From State’s Money Transmitter Act

Effective May 25, 2019, certain blockchain firms may be exempt from being classed as money transmitters in Utah. Specifically, under the Blockchain Technology Act, a person who facilitates the creation, exchange, or sale of certain blockchain technology-related products is beyond the scope of the state’s Money Transmitter Act.

Under the new law’s definitions, however, some private blockchains may not be included in the amendment: “Blockchain” or “blockchain technology” is defined as “an electronic method of storing data that is: (a) maintained by consensus of multiple unaffiliated parties; (b) distributed across multiple locations; and (c) mathematically verified.” (Emphasis added.)

West Virginia Creates New Exemptions From Licensing Requirements

Similarly, West Virginia legislators signed a bill into law that exempts certain payment processors, service providers, and persons facilitating payment for goods or services from the state’s statutory scheme pertaining to money transmission. Though not specific to blockchain, the exemption provides further clarity on the applicability of West Virginia’s licensing requirements. Section 32A-2-3 goes into effect June 7, 2019.

West Virginia’s law comes on the heels of a similar law taking effect in Michigan. As of March 28, 2019, Michigan’s money transmitter statute exempts “agents of a payee”—defined as “a person appointed by a payee to collect and process payments as the bona fide agent of the payee”—from the statute’s licensure requirements so long as certain conditions are met.

Bitstamp Receives License to Do Business in New York

Bitstamp has become the nineteenth company to receive a virtual currency license from the New York State Department of Financial Services. The company, considered Europe’s biggest digital asset exchange, applied for BitLicense through its U.S. subsidiary and received approval to conduct digital currency operations in New York State—including services that allow customers to buy and sell Bitcoin and other unspecified virtual currencies.

The review process for BitLicense entails a thorough examination of the company’s Anti-Money Laundering (AML) and Know Your Customer (KYC) compliance, as well as its anti-fraud, capitalization, and cybersecurity policies. Bitstamp joins other notable providers such as Square, Coinbase, bitFlyer USA, Circle Internet Financial, and XRP II in the so-named “BitLicense Club.”

FinTech Issues Discussed at SEC Speaks Conference

At Practicing Law Institute’s annual SEC Speaks conference, SEC leadership and staff showcased the agency’s 2018 successes and outlined upcoming initiatives. Highlights in the cryptocurrency and FinTech industries included the SEC’s analytical framework for digital assets, published last week by the SEC’s Strategic Hub for Innovation and Financial Technology (FinHub). The SEC also touted cooperation credit given in its recent action against Gladius Network, LLC, which was resolved without penalties after Gladius self-reported and agreed to return ICO funds to investors and register its tokens as securities.

International Developments

China Proposes Ban on Cryptocurrency Mining

The National Development and Reform Commission (NDRC), a state planning body that administers China’s economy from a macroeconomic perspective, proposed adding cryptocurrency mining to its list of 450 wasteful and hazardous activities slated for elimination. The proposed ban is set to come into effect after a public comment period ending May 7, 2019. If implemented, Chinese authorities may begin the process of raising electricity prices for affected businesses to force them to either relocate or close.

The move is no surprise to industry insiders: Cryptocurrency mining is notorious for generating e-waste and consuming large amounts of electricity. Historically, China’s cheap electricity and coal supply has made it a favorite for Bitcoin miners; nearly three quarters of cryptocurrencies are mined in China, and these mining operations generate up to 10 million tons of carbon dioxide annually.

This is not the first time that authorities have cracked down on cryptocurrency mining. In January 2018, China’s top internet-finance regulator, the Leading Group of Internet Financial Risks Remediation, issued a notice demanding companies carry out an “orderly exit” from the business, citing risk of speculation of virtual currencies.

South Korea Announces Possible Regulation Reform

South Korea lawmakers recently announced an intention to revisit the regulatory policy affecting cryptocurrency firms within the country. The statement came during the Deconomy conference in Seoul (2nd Decentralized Economic Forum), and included officials Byung-Doo Min, chairman of the National Assembly; Byung-Kuk Jung, chairman of the 4th Industrial Revolution Committee of the National Assembly; Hee-Kyung Song, co-president of the 4th Industry Forum of the National Assembly; and Hee-Ryong Won, the governor of Jeju Island.

The government has misunderstood the virtual currency and tried to meet the real currency standards, so there are various problems. The industry does not stand still while waiting for the regulatory sandbox authorization, so it is just like confining it in the box.

Governor Hee-Ryong Won proposed to designate Jeju Island as a cryptographic special zone:

If we are concerned about regulation, we can operate a regulatory agency with the government in a limited area called Jeju Island. We will make a case study and try to create a foundation for the government to look at cryptocurrency.

South Korea has a reputation for stringent cryptocurrency regulation, including instituting a ban on ICOs that is still in effect as of January 2019.

]]>https://www.virtualcurrencyreport.com/2019/04/blockchain-week-in-review-week-of-april-8-12-2019/SEC’s FinHub Publishes Framework for Digital Assets and SEC’s Division of Corporation Finance Grants First No-Action Relief to Token Sponsorhttp://feeds.lexblog.com/~r/VirtualCurrencyReport/~3/yKZYGFb1Fk4/
Fri, 12 Apr 2019 15:45:28 +0000https://www.virtualcurrencyreport.com/?p=3891Continue Reading]]>The U.S. Securities and Exchange Commission (SEC) Strategic Hub for Innovation and Financial Technology (FinHub) published a framework on April 3, 2019, for analyzing whether a digital asset is offered and sold as a security under the federal securities laws.

The framework includes “common sense guidance” that provides greater detail and clarity regarding the application of the federal securities laws to digital assets and is intended to be “an analytical tool to help market participants assess whether the federal securities laws apply to the offer, sale, or resale of a particular digital asset.”

Concurrent with the announcement of the framework, the SEC’s Division of Corporation Finance issued a no-action letter in connection with TurnKey Jet, Inc.’s proposed offering of a digital asset for use in its air charter business. The no-action letter provides the first illustrative example of how a digital asset can be sold without having to register it as a security.

This client update provides an overview of the framework, the TurnKey no-action letter and key takeaways for market participants and companies innovating in digital asset products and services.

The U.S. Securities and Exchange Commission (SEC) Strategic Hub for Innovation and Financial Technology (FinHub) published a framework on April 3, 2019, for analyzing whether a digital asset is offered and sold as a security under the federal securities laws.

Concurrent with the announcement of the framework, the SEC’s Division of Corporation Finance issued a no-action letter in connection with TurnKey Jet, Inc.’s (TurnKey) proposed offering of a digital asset for use in its air charter business. This no-action letter provides the first illustrative example of how a digital asset can be sold without having to register it as a security.

An in-depth review and commentary on this development is available here.

ParagonCoin Files Form 10 with the SEC

Following the AirFox Form 10 filing late last month, ParagonCoin recently filed its Form 10 with the SEC in order to register its PRG tokens as a class of securities. ParagonCoin was ordered to file a Form 10 as part of its settlement with the SEC in November 2018.

The ParagonCoin filing appears to be less substantive than AirFox’s filing. AirFox provided significant detail regarding its operations and risk disclosure, while the ParagonCoin filing does not. ParagonCoin takes the position that it is not required to provide risk factors because it is a small business registrant.

The report of ParagonCoin’s independent auditor revealed that ParagonCoin has sustained losses since inception in 2017 and has a deficiency in working capital as of December 31, 2018. This raised substantial doubt about Paragon’s ability to continue as a “going concern,” in terms of its future viability, meaning Paragon’s ability to function for the next 12 months without a threat of liquidation due to failing to timely meet its financial obligations. Paragon states that it is working to generate and raise capital but cannot give any assurances that it will be successful in these efforts.

On January 30, 2019, Cboe BZX Exchange (Cboe) filed a proposed rule change with the SEC to list and trade shares of the SolidX bitcoin. The proposed rule change was published for comment in the Federal Register on February 20, 2019 and the SEC has received comment letters on such proposal.

As stated on March 29, 2019, the SEC is now extending the period in which it can take action on the proposed rule change in order to ensure it has sufficient time to consider it. While the SEC was supposed to make a decision on April 6, 2019, it has now designated May 21, 2019 as the date by which it must approve, disapprove, or institute proceedings to determine whether to disapprove of the proposed rule change. The SEC has also extended the period for SEC action for the Bitwise Bitcoin ETF Trust under NYSE Arca until May 16, 2019.

The Swiss Financial Market Supervisory Authority (FINMA) fined Swiss firm Envion AG for selling tokens without a license. Envion accepted more than 90 million Swiss francs ($91 million) from at least 37,000 investors without the requisite license. Although there was no evidence of misappropriation of funds or an intent to damage Envion’s investors, FINMA found that the conditions under which the tokens were issued were not equal for all investors, the prospectuses did not meet minimum requirements, and Envion did not have an internal auditor.

The Southern District of New York issued a denial of a motion to dismiss in Balestra v. ATBCoin, providing interpretive guidance on when a token might be considered a security under federal law. The court applied the Howey test and held that the facts of the pleadings were sufficient to survive the motion to dismiss. The “investment of money” prong was not disputed by the Defendant and, although there was no formalized profit-sharing mechanism, the court held there was a “common enterprise” due to “horizontal commonality” because the value of the ATB Coins was dictated by the success of the ATP enterprise as a whole. The court also relied on the SEC’s decision In the Matter of Munchee, in which the SEC concluded that its token was a security even though it “did not promise investors any dividend or other periodic payment.” Finally, the court held that the third prong of the Howey test was satisfied based on the content of ATBCoin’s marketing materials and the fact that they were solely responsible for developing and launching the ATB Blockchain—the performance of which largely dictated the value of ATB Coins. Thus, purchasers of the coins were “led to expect profits solely from the efforts” of ATBCoin.

RAND Releases Report on Terrorist Use of Cryptocurrencies

RAND released a report on terrorist use of cryptocurrencies which considers: (1) whether terrorist groups are currently using cryptocurrencies to support their activities; and (2) what properties of new and potential future cryptocurrencies would make them more viable for terrorist use.

The report finds that while current cryptocurrencies are not well matched with all of the features that would be needed and desirable to terrorist groups, they may still be employed for discrete financial activities. It also identified factors that would increase the viability of cryptocurrencies for terrorist organizations, including a single cryptocurrency that has widespread adoption, increased anonymity, and inconsistent regulation.

PayPal Makes Its First Blockchain Investment in Blockchain Startup

PayPal joined a Series A investment in Cambridge Blockchain, a startup that is geared towards helping financial institutions streamline digital identity compliance. A spokesperson said this was PayPal’s first investment in any blockchain company and that it made this investment because Cambridge Blockchain is “applying blockchain for digital identity in a way that we believe could benefit financial services companies including PayPal.” He also stated that “[o]ur investment will allow us to explore potential collaborations to leverage blockchain technology.” The amount of PayPal’s investment has not been disclosed.

International Developments

Chinese Regulator Approves First 197 Blockchain Firms

The Cyberspace Administration of China (CAC) recently released the first list of 197 registered blockchain service providers. According to analysts, this will allow China to “provide a controllable environment to explore blockchain technology in the country.”

The list includes well-known companies and their initiatives, including Baidu Blockchain Engine, Alibaba Cloud Blockchain-as-a-Service (BaaS) and Tencent BaaS (TBaaS). It also includes financial institutions such as the China Zheshang Bank and Ping An Insurance Company, as well as smaller companies such as blockchain-enabled supply chain management service VeChain and parcel delivery service ParcelX.

State Bank of Pakistan Plans to Issue Its Own Digital Currency by 2025

The deputy governor of Pakistan’s central bank recently announced that it aims to issue a digital currency by 2025, in an effort to “promote financial inclusion and efficiency and combat corruption.”

According to Cointelegraph, the move is a reaction to the Finance Action Task Force’s (FATF) repeated concern that cryptocurrencies are used in terrorist financing, which Pakistan has been unable to sufficiently address. In February, FATF said Pakistan had only made “limited progress” on curbing money laundering and terrorism financing.